decided: August 12, 1964; As Amended November 5, December 15, 1964.
Before MCLAUGHLIN and FORMAN, CIRCUIT JUDGES, AND LEAHY, District Judge.
This is an appeal by John H. McKeever, Trustee in Bankruptcy for Connecticut Motor Lines, Inc., from an order by the United States District Court for the Eastern District of Pennsylvania reversing an order of the Referee in bankruptcy.
On May 28, 1958, Connecticut Motor Lines, Inc. was adjudicated a bankrupt in the United States District Court pursuant to its voluntary petition filed that day. Among the claims filed by creditors of the Bankrupt were those for unpaid wages and vacation pay earned within the immediate three months period prior to bankruptcy, and in some instances for wages and vacation pay earned within an earlier period. Those with claims for wages and vacation pay earned within the three months imediately preceding the bankruptcy rightfully asked for, and were allowed, a priority distribution under Section 64, sub. a(2) of the Bankruptcy Act.*fn1 Claimants with a wage accrual which preceded the three months' period qualified for dividends as general creditors of the Bankrupt.
The Referee's order provided for a distribution of $20,154.81 to be made to wage claimants entitled to Section 64, sub. a(2) second priority status. After isolating other priority matters, a balance of $145,313.42 was available for distribution of dividends to general creditors, including the pre-three month wage claimants. The Referee's order neither made provision for deductions of employees' contributions for income withholding and social security taxes*fn2 from the sums distributed to priority and non-priority wage claimants, nor for payment of the employer's social security excise.*fn3 Accordingly, the United States filed a petition for review with the District Court, that court reversing the Referee and holding the Trustee liable for all the above-mentioned taxes as a first priority administrative expense.*fn4
Though novel for this court, the issue presented on appeal is a recurring one, viz., what status in the order of creditors' priorities is to be given a Government claim for income withholding and social security taxes arising from wages accrued prior to bankruptcy, but paid during bankruptcy as a second priority matter, or as a dividend to general creditors?
It is well settled that taxes arising from transactions completed in all respects prior to bankruptcy are to be treated as fourth priority items.*fn5 The problem faced here, however, is a hybrid - there has been an accrual of wages prior to bankruptcy, but their payment was held in abeyance until the second priority and general creditor distributions under the Bankruptcy Act. Though the Government's right to income withholding and social security taxes is fixed in the struggle among pre-bankruptcy creditors, the provisions of the Bankruptcy Act are clear neither as to what constitutes a pre-bankruptcy tax claim subject to fourth priority status as distinguished from a post-bankruptcy tax claim, nor what the Government's rights are once a post-bankruptcy tax claim is established. In its relationship to an estate as a taxpayer, the Government "finds itself tacitly referred to the wisdom of the courts."*fn6
The first enunciation on the subject appeared in the leading case of United States v. Fogarty*fn7 and subsequent cases,*fn8 all relied upon by the Government but questioned by the Trustee. In upholding the Government's claim for taxes based on wages earned prior to bankruptcy, but distributed in bankruptcy, facts of the type before us on this appeal, the United States Court of Appeals for the Eighth Circuit, in Fogarty, concluded that as the Internal Revenue Code made the wage payment a prerequisite to the attachment of the tax, and as that wage payment was accomplished after the filing of the bankruptcy petition, the Government's tax claim was a post-bankruptcy claim. The Eighth Circuit then held that such tax claims were not fourth priority items, but as post-bankruptcy expenses were first priority costs and expenses of administering the bankrupt's estate.*fn9
In determining whether to accept as persuasive precedent the ruling in United States v. Fogarty, analysis of the foundation of this leading decision can be revealing.The ultimate result in Fogarty rests on a number of cases which lend little support to that holding, and if anything, detract from the reasoning of the Eighth Circuit.*fn10 In all the cases cited, the trustee or bankrupt was taxed on activities involved in further developing the bankrupt's assets or in seeking to maintain such assets for the maximum benefit of creditors. Post-bankruptcy taxation such as this has long been viewed by the courts as part of classic administration expenses. It is of import then that one of the leading treatises, in noting the thrust of the Fogarty ruling, mistakenly cited the case for the classic proposition that "any such taxes as accrue during continuance of business by a receiver or trustee are considered part of the expense of administration."*fn11 Such a misconception of Fogarty could have arisen because courts construing activities aimed at developing or preserving the bankrupt's assets as a basis for a first priority tax claim have implied that any activity, short of a purpose on the part of the bankrupt, trustee, or receiver to develop or maintain assets for the maximum benefit of creditors, would not be a basis for a tax claim entitled to first priority status.
This court, in upholding New Jersey's claim for franchise taxes accruing during a bankruptcy reorganization, stated:
"* * * the order appointing the trustees specifically referred to the 'franchises' of the corporation and required the trustees to protect and conserve this asset as well as other assets transferred to them. * * *
"* * * [The franchise tax] thereby became one of the expenses of administration incurred by the trustee."*fn12
United States v. Fogarty has, in reality, stood on precedent which has recognized a cleavage between allowing as first priority matters, taxes arising from post-bankruptcy activities geared towards development or preservation of the bankrupt's assets, but disallowing as an expense of administration, taxes attaching to post-bankruptcy activities incidental to the development or preservation of the bankrupt's assets. This is the measure both by which Fogarty becomes of little value to this court and makes necessary an independent analysis of the rationale of the Fogarty rule.
Most post-bankruptcy taxes have been placed into the category of costs and expenses of administration, and as such, these taxes have been entitled to first priority status. This position is the natural consequence of the broad principle that "the cost of protecting a fund in court is everywhere recognized as a dominant charge on that fund."*fn13 Section 64, sub. a(1) of the Bankruptcy Act also recognizes that costs associated with the distribution of the fund are expenses of administration.
"* * * if the tax [on wages accruing prior to bankruptcy but allotted in bankruptcy] were on the distribution of the wage claim, the tax could be a valid expense of administration since distribution is a part of administration; but the tax in question is not a tax on distribution but a tax on wages paid."*fn14 Thus, as the tax on such wages as is before us neither has a relationship to the cost of protecting or developing the bankrupt's assets, nor can be reasonably considered a tax on the mere distribution of the ...